Online payment platform PayPal has moved the Delhi High Court against a single judge’s order, which ruled that it was a “payment system operator” under the Prevention of Money Laundering Act (PMLA) and is obliged to comply with “reporting entity obligations” under the law as a result.
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A division bench of the HC is hearing PayPal’s challenge to the July 24 order of a single-judge bench of Justice Yashwant Varma. The single judge bench had noted that all elements of the transaction connected with a payment being effected between two parties would appear to fall within the scope of the expression “payment system” under the PMLA, and the “technology on which the platform of PayPal rests enables the transfer of money between parties at different ends”.
Justice Varma, however, quashed the monetary penalty imposed by Financial Intelligence Unit-India (FIU-India) on PayPal for failing to comply with the reporting obligations as placed under the Prevention of Money Laundering (Maintenance of Records) Rules.
What is PayPal’s claim, what is a payment system operator and a reporting entity and what does the law say on their obligations? We explain.
What was the challenge before the single judge?
PayPal moved the HC against a December 17, 2020 order of FIU India holding it to be a “reporting entity” under the PMLA, while also imposing monetary penalties on it for failing to comply with the “reporting obligations” under the Prevention of Money Laundering (Maintenance of Records) Rules.
FIU India is the central national agency responsible for receiving, processing, analysing and disseminating information relating to suspect financial transactions. It is an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the Finance Minister.
And what were PayPal’s arguments?
PayPal had argued that it is not a “payment system operator” as defined under the PMLA and is not engaged in “rendering services relating to clearing, payment or provision of settlement between a payer and a beneficiary”. PayPal said that it only provides a “technological interface”, enabling export-related transactions that may be undertaken by an Indian exporter and an overseas buyer. In the chain of transactions, at no stage is PayPal engaged in the “actual handling of funds”, it said.
PayPal additionally relied on the RBI’s stand in another matter, where the central bank had said in an affidavit that PayPal is not a reporting entity which operates a payment system under the Payments and Settlement Systems (PSS) Act. The reliance was made, arguing that the definition of payment system under PMLA and PSS Act are identical.
So what is the difference between a payment system and a payment system operator?
A Payment system is a system which “enables” payment between a payer and a beneficiary and “includes” systems which enable credit/debit card operations, money transfer operations or similar operations. In other words, it is a mode by which two persons/entities can transact monetarily.
The PMLA defines a “payment system operator” as a person – which includes an individual, a company, a firm etc., – who operates a payment system and such person includes his overseas principal (an individual or a company which resides or is registered outside India and owns/manages directly or indirectly activities of the payment system in India).
A “reporting entity” under the PMLA means a banking company, financial institution, intermediary or a person carrying on a designated business or profession; the definition is broad as it encompasses not just companies but a person.
A “person” under the PMLA is an inclusive definition which includes an individual, a firm, a company, and an agency among others.
What are reporting entity obligations?
The PMLA lays down certain obligations of banking companies, financial institutions and intermediaries, i.e., reporting entities. Some of them include maintaining a record of all transactions, keeping them confidential, and verifying the identity of their clients under the Aadhar Act. The reporting entities are also mandated to maintain information on “enhanced due diligence” for a period of five years.
How does PayPal work?
Explaining its business model before the single judge, PayPal said that its work begins when a foreign entity contacts an Indian Merchant for the purchase of goods. Once they confirm the purchase, the foreign entity (which does not have an account with PayPal India) proceeds to make a payment to the Indian Merchant who (onboarded by PayPal India) provides the “PayPal India link/check-out” page to the foreign entity.
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The foreign entity then clicks on the link/check-out page and makes payment by credit/debit card/Online Banking etc. to the Indian Merchant. The money is debited from the instrument of the foreign entity and collected in the “Authorised Dealer Nostro Collection Account” (in Foreign Currency) with the Authorised Dealer Bank. The said Authorised Dealer Bank then transfers the same to the “Authorised Dealer Bank Export Collection Account” (in INR) held in India with the Authorised Dealer Bank who then transfers the same to the Indian Merchant.
In other words, PayPal has said that it is only a “technology platform” as at no stage does it handle the funds which move between the Indian exporter and the foreign buyer and the money is directly handled and systematically routed by the AD Banks at the end of each transaction. PayPal therefore said that the Authorised Dealer Banks both overseas as well as in India are reporting entities under the PMLA and since PayPal only provides a link which is subsequently utilised for the effective transfer of funds it can’t be termed as reporting entity under PMLA.
An Authorised Dealer (AD) bank is a financial institution authorized by the Reserve Bank of India (RBI), to deal in foreign exchange transactions–such banks help in carrying out export and import transactions.
What did FIU-India argue?
The FUI argued before the single judge that merely because PayPal is not recognised as covered by the PSS Act provisions that would not mean that it is not to be treated as a “payment system operator” under PMLA.
The body said that the framers of the money laundering law chose to independently define “payment system” and “payment system operator” under PMLA, rather than merely adopting the provisions of the PSS Act. This indicates the “legislative intent” to confer a different and distinct meaning upon the phrase “payment system” and that the PMLA has a dual character as it contains both penal and regulatory provisions.
FIU said that PayPal principally discharges a role of facilitating payment transactions and thus its technological platform would fall within the ambit of a payment system under the PMLA.
What the single judge’s verdict said
The single judge first said that the PSS Act is concerned with payment aggregators and Intermediaries who are engaged in the “direct handling of funds received from customers and the various aspects connected therewith including the settlement and netting of such funds”. The HC said that this Act does not appear to control technology platforms and facilitators, who are not directly concerned with the handling of funds, but may be an intermediary in the “movement of funds”.
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The HC thus rejected PayPal’s argument that just because it is not recognised as a payment system operator under the PSS Act it can’t be one under the PMLA as well. Examining the definition of payment system under the PMLA the HC observed that the use of the words enable and involve clearly appears to suggest the “legislative intent to cast a wide net in order to enable the provisions of the PMLA to operate effectively and thus regulate a whole spectrum of activities connected with the movement of funds between two parties”. In other words, the HC ruled that the scope of the definition is wider.
Observing that PMLA is a special statute dealing with money laundering as opposed to the PSS Act, the HC concluded that even if PayPal is not engaged in the handling of funds at any stage of the transaction, it would still be recognised as a payment system operator under the PMLA.
